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The U.S. Small Business Administration is withdrawing plans to change the way small businesses are defined, reportedly amid strong criticism of the plan from business groups.

The SBA was planning to define more businesses by the number of employees instead of by their revenue, a move which they said would make 35,000 new businesses eligible for SBA-backed loans and a chance to bid for federal government business. But critics said the changes would exclude another 34,000 businesses.

The SBA announced June 30 plans to withdraw the proposed rules and hold public hearings around the country to get business input.

"[The] SBA wants to make the SBA more like the small businesses it serves every day, and that means being responsive to our customers," said Allegra McCullough, SBA associate deputy administrator for government contracting, in a prepared statement. "That is why we have decided to revisit this issue."

The public comment period for the rule was to expire July 2, but the SBA has extended it another 45 days, presumably still looking for thoughts on what the right criteria would be.

While the SBA says the proposed rule change would simplify things and make more small businesses eligible for SBA programs, business groups said the cost to other businesses that would become ineligible is too high. And even for those who would qualify, the proposed federal budget for fiscal 2005 provides no increase in funding for loan guarantees, which may make it tougher for businesses to get financing.

A loan guarantee is an agreement between the SBA and the lender that says that if the borrower defaults, the federal government will cover most of the loaned amount.

SBA loans benefit small-business owners like Mike Droese, who is moving his Steiner's Jewelry store, in San Mateo, Calif., into new, larger space this summer, thanks, in part, to a $1.33 million dollar SBA-backed loan he received in 2002 from U.S. Bank.

"It was my first experience doing a big deal like this. It's a frightening thing. But I stopped my search for financing when I found out about the SBA loan," says Mr. Droese. The lender made the process as easy as possible to understand and got him the financing to start his business.

Retail businesses are among the most likely to have been affected by the proposed new rules. Today, a retailer can qualify for a loan guarantee if it has less than $6 million in annual revenue. Under the proposed new rules, it would have to have fewer than 50 employees.

A group calling itself the Coalition to Preserve Small Business had planned to speak out against the changes at a House Small Business Committee hearing scheduled for July 14 in Washington, D.C. There was no immediate word on whether the hearing would go forward.

"The SBA says there would be a gain of 35,000 businesses who qualify, but 34,000 would lose [eligibility]," says Lisa Greer, an organizer of the coalition. "This needs to be studied more at this point."

The changes could also exclude businesses from federal government procurement programs, Ms. Greer says. The U.S. Department of Defense, among other federal agencies, gives small businesses a chance to bid for some contracts for goods and services.

The size changes are based on "flawed data," Ms. Greer says. Instead of being based on 1997 U.S. Census data, which is outdated, it should be based on 2002 census data, which is due out later this year.

Defining a small business by the number of employees rather than revenue may hurt restaurants, in particular, because they employ many part-time employees, such as the wait staff, but still struggle to make sales, she says.

Whatever criteria the SBA eventually proposes, there may be other troubles ahead for SBA borrowers.

The proposed budget for federal fiscal year 2005 contains a "zero subsidy" provision for SBA, he says, which means no new appropriation would be made to back more 7-A loans — the type typically granted to small business startups.

Any additional money for loan guarantees would have to come from additional fees on businesses using SBA programs or a limit on the percent of the loan the SBA will guarantee.

That will make lenders more reluctant to issue loans to a risky business, says Ralph Barnett, executive vice president and SBA lending group manager at Bridge Bank, N.A., of Santa Clara.

"I'm probably going to need a full 75 percent to 80 percent guarantee and if the SBA says it will only guarantee 50 percent, chances are we would adjust our lending criteria to that particular industry."